New Markets Blog

5 lessons from companies moving into services

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Moving into services has become a hot business strategy.  Consider just some recent examples:

• Intel is purchasing security firm McAfee for over $7.6 billion, aiming to integrate its chips with McAfee's software and  services to constantly monitor new threats
• Ford is enabling customized configurations of its cars' software, which could range from transmission preferences to music, GPS software and much more
• Nokia spent over $8 billion to purchase a single company specializing in mapping software, and has supplemented that move with big spending on buying and developing other software and services to differentiate its handsets
• Procter & Gamble has created a string of car washes branded "Mr. Clean" in an attempt to move into this highly fragmented, $35 billion industry
• Scotts has moved its lawn care brand into the lawn services franchise industry 

The list goes on and on.  Across a wide range of traditionally product-oriented industries -- medical devices, chemicals, high-tech, and more -- companies have moved into services to augment their offerings.  What can we learn from these experiences?

The attractions of the strategy are clear.  Moving into services allows firms to target vast pots of money spent after products are bought, services are often sold at higher margins than products, tight integration of product and services can differentiate offerings, customers can be locked into a single supplier, and new markets can be accessed through creating a full solution to customers' problems.  Some companies have exploited the strategy to great effect -- IBM's move into services during the 1990s powered the company's growth, entrenched its customer relationships, and helped its hardware business as well.

But this is not easy to do.  The experience of companies that have transitioned from products to services shows 5 lessons:

• Create a new experience, not just a new business model -- While Nokia phones now offer excellent mapping and a range of other services through the company's Ovi app store, the experience is not that distinct from what is available on competitive handsets.  Nokia gets modestly more revenue from providing both the hardware and the software/services, but at a real cost in terms of reduced flexibility and sales channel alienation.  Contrast this to Ford, which needs to control the hardware to enable services like tuning transmissions to individual preferences, and can therefore offer customers an experience unmatched by other carmakers
• Be certain about an industry's direction before abandoning flexibility -- One clear lesson of new markets is that a number of variables can impact a nascent industry's evolution.  Eventually the shape of the industry becomes clear.  An integrated product-service solution may be hard to iterate, or it may make things more malleable versus having to rely on outside partners.  The flexibility of integrated vs. modular solutions depends on both system architecture as well as industry dynamics.  It is important to retain the ability to evolve quickly during an industry's early days.  Once a business is more mature -- e.g. computer security -- it can make more sense to invest fixed costs into product-service integration, as Intel will do with McAfee
• Have a crystal-clear channel strategy -- When IBM moved heavily into system integration, it alienated prior sales channel partners that made hardware recommendations to their IT services clients.  IBM understood the ramifications, and it had a substantial direct sales capability.  In many industries, sales channels not only move boxes but also install and service products.  Companies must have a very well-defined view about whom they will alienate through moving into services, how they will fill this gap in their ecosystem, and how they will keep other key partners on-side during the transition
• Set up the organization to handle distinct control systems -- Running a services company is extremely different from managing a product firm.  The ways that companies discover service shortcomings, the autonomy given to front-line staff, planning processes, and much else is distinct.  This seems to be obvious, but countless companies have put executives with product backgrounds into service management roles without a roadmap on how to act differently.  This can create all kinds of problems from service development through to execution and performance measurement
• Prepare to balance -- There is no cookbook approach to manage the transition to services.  Rather, executives need to constantly balance competing imperatives -- service customization vs. the need for scale economies, leveraging the product salesforce vs. creating skewed sales incentives, locking in customers over the long-term vs. winning wary customers in the short-term, and so on.  It can be extremely useful to execute this transition with people on board who have seen this movie before, so long as they recognize the need to adjust their approach according to circumstances that include product lifecycle, channel economics, value created for the customer, competitive intensity, trackable frontline performance data, and others

The business strategy of integrating products and services can be compelling.  Indeed, it may be vastly underexploited in some sectors.  To take one example, Abbott's recent acquisitions of Indian pharmaceutical companies makes it the leader in this major growth market, but without a complementary services offering that differentiates Abbott's therapies it is not clear how the firm makes itself a better owner of these properties than local Indian managers.  As companies embrace this strategy, they should take great care to learn from others' experiences on this road -- it reaches a compelling destination, but the journey is challenging.

Click for more of New Markets' thinking on business models.

Starting an innovation program -- 3 watch-outs

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Everyone loves innovation.  It's like efficiency -- who is against efficiency?  Yet people tasked with starting an innovation program quickly find that there are innumerable roadblocks.  Why do these exist, and what can you do about them?

Usually, innovation roadblocks exist because current practices help staff to accomplish certain objectives, and shaking things up will threaten those aims. Perhaps these objectives have not been officially articulated -- they may include things like make me look good, don't force me out of my comfort zone, and don't add on additional work.  But they are quite real, and all the trappings of innovation (one can imagine a vast sea of ping-pong tables and purple paint) will not obscure the fact that the organization adheres to these anti-innovation prioities.

Rather than leaping for the paint cans, or even planning a series of capability-building initiatives, organizations do best when they start an innovation program by following three simple principles:

• Begin with the innovation strategy -- Just as companies succeed in the market by choosing where to keenly focus, so too should organizations tie an innovation program to a handful of core objectives.  Those objectives should be linked closely to business strategies, so that when embracing innovative behaviors entails costs (in terms of staff focus, embracing upfront inefficiencies, and protecting some small long-term investments) there is a clear business justification for sticking with the innovation program.  The innovation strategy should include elements such as a high-level portfolio plan for how much effort should be expended on what types of innovations (disruptive, sustaining, open, business model, etc.).  It should also spell out how innovation plays a role in accomplishing major business objectives, what that means in terms of specific capabilities needed, and what is the exact nature of the capability gap.  The innovation strategy says nothing about how these gaps will be filled.  Instead, it is a way to align key decision-makers around priorities so that they stick by them, and so that the innovation program can focus its energies on making an impact where it matters most. 
• Think concurrently about broad capability-building and specific innovation projects -- An innovation program need not entail focus just on far-out concepts (Whirlpool staff once spent a year developing a concept for people to race stationary bikes against each other over the Internet...yikes!).  It may include tools that help innovate in the everyday business, mechanisms to foster better cross-functional collaboration, competitions across the organization, suggestion programs, awards, performance metrics, and many other elements.  It is important to launch the program elements in a phased manner, so that the first priorities clearly support the innovation strategy, cause minimal dislocation, and have an obvious demonstration effect.  Specific innovation projects can do this.  The projects may involve creating new concepts (remember, no Internet bike racing) as well as rolling out mechanisms like competitions or suggestion programs in highly targeted ways that ensure extensive participation and impact.
• Create pull from the organization and change agents to meet grassroots demand -- Change seldom works when it relies solely on a push from above.  In large organizations, inertia will fight all but the most focused initiatives, and ultimately a program to build innovation capabilities has to become quite multi-dimensional.  The alternative is to combine senior-level support and a basic innovation program infrastructure with grassroots demand from deep within business units for the "secret sauce" that has clearly succeeded elsewhere.  The specific projects referenced above can create this demonstration effect.  Then, change agents seeded throughout the organization can help to translate the program to varying business unit and functional contexts (the innovation needs of people in supply chain management will be vastly different from those in research).  Change agents were over-used and then maligned during the 1980s (T-shirts emblazoned with "CHANGE AGENT" were one horrendous form of abuse) but the basic concept still makes a great deal of sense.  There should be a relative handful of people with deep training in innovation approaches and the organization's program, supplemented by short training / corporate communication for the vast bulk of staff.  

Taken together, these approaches create a sustainable innovation program.  There is no big bang, but rather a building of momentum.  It takes patience and planning.  And it works.

Click for more of New Markets' thinking on innovation capabilities.

Skype IPO illustrates growth potential of new markets

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Today's filing by Skype of a pre-IPO S-1 contains volumes of interesting data about the company's potential to tackle new markets.  On top of the company's present accomplishments (among them -- 560 million registered users and 1H 2010 revenues over $400 million), the firm seems to have tremendous growth potential.

That growth will come in ways distinct from how the firm has often touted growth in the past.  At 560 million, the company's user base has limits on how much further growth is feasible given the total penetration of PCs/Internet cafes, and limited appeal of the service to people lacking the occasion to call overseas.  Rather, growth can come through monetization.  With current paying users spending around $8 per month, there is ample potential for these sums to increase, even compared to typical spend of heavy cellphone users in emerging markets.  Less than 2% of Skype's users currently provide revenue to the company, providing vast headroom to expand.

Revenue potential lies not only in the ability of Skype users to call from their PC to phones for a small fee, but also in areas such as:

• Exploiting high-bandwidth cellular networks to undercut traditional tariffs for mobile calls
• Embedding Skype functionality in a broad range of consumer electronics, allowing easy communication and sharing (the firm already has deals with LG, Panasonic, and Samsung)
• Integrating live talk with the web, for instance through click-to-Skype services on e-commerce sites
• Advertising to a network that rivals Facebook's size (users spent 152 billion minutes on Skype last year)
• Upgrading users to value-added services (currently the firm gives away Skype-to-Skype video calls, resulting in an astonishing 40% penetration, but group video calls are targeted for premium pricing)
• Creating business applications to integrate Skype into the workplace, e.g. through linking it to the corporate PBX or displacing conferencing vendors like Webex

Skype has a business model which provides unique advantages in these quests.  It plays "over the top" of existing telecom networks, leveraging their enormous sunk costs in infrastructure and exploiting networks' temptation to fill use this infrastructure as much as possible, even at cut rates (this is why there is such a disparity between voice and data tariffs on traditional networks).  Skype's own infrastructure is distributed and largely peer-to-peer, creating a distinct cost advantage against established players.  Furthermore, many of its services are paid by users in advance, lowering the firm's need for working capital.  Finally, some telecom firms rank among the world's largest advertisers, but Skype has very modest marketing costs.

In short, this is a very attractive business that seems to be seeing just the beginning of its full potential.  Skype's strong position provides several lessons about new markets:

• Network effects provide powerful advantages although they take time to build.  The money is not in the network itself, but in what it can enable once it is deeply entrenched.  Skype can monetize this network in a great many ways, and it seems impossible to displace
• Network effects are most enduring when they create both customer experience as well as cost advantages.  While large telecom players also have network effects, these mainly create a superior cost position.  Skype's network also creates a superior content position (and their lean business model makes the large firms' costs seem extravagant)
• Open platforms are one of the most powerful generators of new markets.  As the railroad, electric grid, and Internet proved, a platform that facilitates invention can lead to all kinds of unexpected growth and new riches for the platform's owner.  Skype's integration of Internet and voice communication is a powerful platform that the firm has recognized through creating an open toolkit for software developers
• The center of an industry's profitability tends to shift during its evolution.  In mobile communications, infrastructure vendors used to make a lot of money, then handset makers, then cellphone networks.  Now Skype may grab a large share of profits through owning the customer and commoditizing other players

There is one downside for Skype.  People who have studied the patterns of new markets should be wary of partnering with this firm, which may become a communications colossus.  Although its profits may never rival those of the traditional industry, its global scale and ability to up-end industry business models threaten existing players in many ways.  If these players hold back from partnering with Skype, its rapid advance may slow.

Even with this caveat, Skype's future looks bright.  Many observers have focused on the size of Skype's network, but it is the headroom to monetize this network that is truly enticing.

Click for more of New Markets' thinking about telecom and business models.